Description

MegaStudyEdu is the market leader for online and offline cram school courses in Korea. It has a market cap of $550m and trades $3m ADV. The company has exhibited strong historical revenue and profit growth, free cash flow generation, and 20%+ ROE. The stock is down 40% over the past year and now trades at a record low 7.1x trailing P/E. We believe the reasons for the stock’s sell-off will prove transitory and are mostly unrelated to the company’s fundamentals. There is 70% upside if the stock merely rerates to its historical average valuation. Continued growth, both organic and via a pending acquisition, could generate even more upside over the next two years.

Brief Background

MegaStudy Co (“MSC”) was established in 2000 by Son Joo-eun, a star cram school social studies teacher turned businessman. Mr. Son remains CEO and Chairman of the company today, and his younger brother, Son Sung-eun, is also a board member and co-CEO. Cram schools, or hagwon in Korean, have been popular since the 1980s due to the cultural importance of education and entrance exams in Korea. MSC began offering online versions of high school cram school lectures at c.1/3rd the price of competing offline lectures when the company was founded. 

MSC IPOed on the KOSDAQ in November 2004. The ease of use and very competitive price of MSC’s online lectures helped the company rapidly gain market share from offline cram schools. MSC’s revenue grew at a c.50% CAGR for 10 years through 2010. MSE then entered a difficult period between 2009-15 due to changes in the way questions were selected for the College Scholastic Ability Test (“CSAT,” also referred to as the Suneung or Korean SAT). The CSAT is offered in November/December every year and takes 9 hours to complete. It is often considered the most difficult college entrance exam in the world.

In 2004, the Korea Education Broadcast System (“EBS”) launched a free online test preparation platform, but the platform was generally viewed as inferior to private cram school courses. In 2009-2013, the government began changing the CSAT questions to be more directly linked to example questions provided on the EBS platform. This led to a decline in the market for private cram schools because more parents and students concluded that the free EBS platform was sufficient. However, as this happened, many people believed that the exam became too easy and predictable. Starting around 2015, the linkages between the EBS materials and the CSAT exam questions were slowly reversed. This led to a rapid recovery of the private cram school industry.

In May 2015, the majority of MSC’s education assets were spun-out into the separately listed MegaStudyEdu (“MSE”), which is the stock we recommend owning. MSC remains listed and is now effectively a holding company for the Seo family. This corporate structure with a listed holding company and listed operating company(ies) is very common in Korea. The two Son brothers collectively own 27.06% of MSE and 33.92% of MSC. MSC also owns an additional 6.0% of MSE.

After 2015, the EBS became a less effective platform to prepare for the CSAT and MegaStudy’s education business began to expand rapidly again. Between 2016-2022, MSE’s High School business grew sales at a 23% CAGR and operating profit increased 33x from a low base. MSE’s consolidated sales grew at a 30% CAGR over the same period and operating profit increased 39x, also from a low base. MSE’s growth in the High School segment was also aided by the introduction of MegaPass, an all-you-can-eat product for all of the online high school lectures offered by MSE. MegaPass helped MSE gain even more market share, which the company estimates is 65-70% today. There are large economies of scale in the online cram school business because a larger student base allows MSE to attract and pay star teachers and the incremental costs for adding new students is relatively low. In addition to MSE’s core online High School cram school business, the company also offers some offline cram school courses and Megastudy Academy boarding schools. Data is not disclosed by the company, but we believe approximately two-thirds of MSE’s High School segment is from online sales and one-third is from offline sales.

MSE also has a #1 or #2 market share for online courses for elementary and middle school students. EliHigh is MSE’s brand for elementary students (8-13 years old) and MBest is MSE’s brand for middle school students (13-16 years old). MSE is also entering a new segment for younger kids (5-7 years old) but this is not material yet. 

Below is a brief summary of MSE’s key business segments as of 2022. It is clear that the High School and Elementary/Middle School segments are the most important historical drivers of earnings. 

The company does not disclose volumes, but historically management has increased the High School course ASPs at 5-7% p.a. This implies that High School sales volume has been growing at c.10-15% p.a. MSE has not raised the price for Elementary and Middle School products in recent years, and this implies that sales volumes have been growing at 25-60% p.a. via market share gains and increased penetration.

Financials

Below is a brief summary of MSE’s key financials. The numbers demonstrate MSE’s strong growth, double-digit operating margins, high conversion of profits into free cash flow, 20%+ ROE, and a net cash balance sheet. It should be noted that the periods between 2015-2018 were recovery years from a low-base as the impact of the CSAT test question changes benefited MSE’s business. Furthermore, 2020 was negatively impacted by Covid since c.30-40% of MSE’s business is offline which experienced negative operating leverage during Covid.

MSE’s stock is very cheap trading at only 7.1x trailing P/E, 5.0x EV/EBIT, and 1.75x P/B with a 9.4% FCF Yield and a 3.4% dividend yield. MSE is trading at its lowest P/E ratio since it was spun-out of MSC. The stock has traded at an average trailing P/E of 20.7x since listing, or an average of 12.0x trailing P/E if we exclude the periods impacted by unusually low earnings during 2015-17 (CSAT regulations) and 2020 (Covid impact). Therefore, we believe the stock is trading at a 40% discount to a normalized historical P/E ratio for MSE.

Reasons for recent sell-off

MSE’s stock has sold off 40% from the March 2022 high. We believe there are several reasons the stock price has been weak, which are mostly unrelated to the company’s fundamentals.

1. Fidelity has been selling down their position from c.9.4% of s/o and c.15.3% of the free float in Q1 2022, down to only 2.36% of s/o as of the last filing date in February 2023. We are not sure why Fidelity decided to sell, but we would not be surprised if they sold the stock aggressively as it became a smaller percent of their portfolio. This might explain why MSE’s stock price was so weak in Q1 2023. We believe Fidelity has either fully exited the stock by now or is mostly done selling.

2. Failed sale of management stake to local private equity firm MBK Partners. In July 2022, MBK partners proposed to purchase the Son family’s 35% stake in MSE. The rumored transaction price was W150,000 per share which equated to a c.100% control premium compared to the undisturbed price and 50% above the stock’s all-time high. Ultimately the discussions broke down based on a disagreement around price and possibly a few other risks cited in the press (see appendix). The market may have also taken a negative view on the Son family wanting to sell and the failure of the deal to close (although it is unlikely that minority shareholders would have ever received the same offer from MBK based on Korean regulations and the way private equity buy-outs are typically structured in Korea). We take some comfort in the fact that the rumored sale price is 140% higher than today’s stock price.

3. ST Unitas acquisition. On October 21, 2022, MSE announced an acquisition of ST Unitas Co from Bain Capital for KRW 172 billion ($128m). The proposed acquisition deal value compares to MSE’s market cap of $555m and $57m of net cash on the balance sheet. ST Unitas is the leader in civil servant test-prep courses with c.50% market share and approximately W220b of sales and c.50k students. They have star teachers in five key course segments: English, Korean Language, Korean History, Administration, and Administration Law. MSE’s management believes that the combination of MSE’s existing Adult segment and ST Unitas will create a combined division with 70% market share in civil servant test prep. The combination will also create opportunities for synergies through increased scale and a reduction in the cost of teachers. MSE has successfully used a similar strategy to consolidate market share and improve margins in its cram school business over time. MSE’s existing Adult segment is loss-making and creates an 18% drag on group profits while ST Unitas is approximately break-even. The deal is being reviewed by Korean competition authorities and a decision is expected by October 21 this year. We think the uncertainty around this acquisition, both in terms of its approval and synergy execution risks, may be weighing on the stock price. We believe a regulatory approval of the deal would likely be positive for the stock price.

4. Rumors of a star teacher retiring. In June 2022 there was a rumor that MSE’s star math teacher, Mr. Hyun Wu-jin, was going to retire. The stock price dropped 6% on the day the rumor surfaced. This proved untrue and Mr. Hyun is still working for MSE.

5. High earnings base concern. We believe there may be a view in the market that MSE may be reaching peak earnings because of the exceptional growth achieved in the past two years. While we do think that earnings growth is likely to slow this year because growth in 2021-22 was partly driven by a normalization of MSE’s offline businesses, we think it is unlikely that MSE’s earnings have peaked. Management doesn’t release official guidance but they did mention that they do expect double digit growth in 2023. Sell-side consensus is forecasting mid- to high-single digit growth in 2023. As discussed above, we also think that approval of the ST Unitas acquisition could generate significant additional earnings growth in 2024 and beyond.

6. Retail investors chasing thematic stocks. MSE is a KOSDAQ listed stock, which is a Korean exchange for smaller companies. Retail investor participation on the KOSDAQ is high. The KOSDAQ has been one of the best performing markets this year but performance has primarily been driven by EV battery material stocks. This thematic rotation, which has probably been a headwind for MSE’s stock, is not uncommon on the KOSDAQ but it rarely lasts for an extended period of time.

Risks

• Demographics: Korea’s population is aging, birth rates are very low, and younger age groups are shrinking. The high school age group is approximately 28% smaller than five years ago. We think MSE still has some opportunities to consolidate market share, raise prices, and expand the adult education segment, but over time the demographics will continue to pose a headwind.

• Regulatory Risks: Although we don’t think the near-term regulatory risks are particularly high, we would be remiss not to mention this as a risk given the turmoil caused by the change in the CSAT test questions a decade ago. Domestic investors have a long memory of the regulatory issues and this will likely cap the valuation multiple MSE can achieve. International investors’ recent experience with even more severe regulatory tightening in the Chinese private tutoring market is also unlikely to be forgotten soon.

• Star teacher risk: The rumored loss of Mr. Hyun mentioned above highlights the importance of star teachers in the business. If key teachers retire or are hired away by competitors it could negatively impact sales. .

• Competition: MSE is the market leader but there are 3-5 competitors in most market segments. If any of these competitors are able to take market share from MSE through enhanced product offerings or lower prices, MSE’s performance could suffer. 

• Slowing Civil Service Market: Civil service employment expanded under the prior Moon administration. Under the more conservative Yoon administration which was elected in 2022, the growth in the civil service market has slowed. This may cap near-term sales growth opportunities for MSE’s Adult segment and ST Unitas.

• Management Has Tried to Sell 3 Times: The Son brothers have tried to sell their stake in MSC/MSE three times in the past. While we think this is likely due to their decades long involvement in the business and increasing age (62 and 56 years old), it might also raise suspicion around possible fundamental reasons they want to sell.

• AI Learning: We don’t believe this is a short term risk, but it does seem possible that AI-based education courses could eventually complement or even replace teacher-based learning. If this happens and MSE is unable to adapt, the business could be displaced and lose market share, or the economics of the business could deteriorate.

Appendix

MegaStudy Press Articles

• https://www.nytimes.com/2009/06/02/business/global/02cram.html

• http://www.koreatimes.co.kr/www/biz/2017/08/488_106156.html

Hangwon

• https://en.wikipedia.org/wiki/Hagwon

CSAT

• https://en.wikipedia.org/wiki/College_Scholastic_Ability_Test

MBK Partners attempted acquisition of MSE

• https://pulsenews.co.kr/view.php?year=2022&no=660515

• https://www.kedglobal.com/mergers-acquisitions/newsView/ked202209020013 

Korea Education Broadcast System (EBS)

• https://about.ebs.co.kr/files/about/files/global/Introduction_of_EBS.pdf

MegaStudy Products

• www.megastudy.net

MegaStudy IR Sites

• http://corp.megastudy.net/bbs/board.php?tbl=bbs44 

• http://www.megastudyholdings.com/board/ir_room.asp

Catalyst

End of large shareholder selling, earnings growth, completion of pending acquisition